Sunday, June 22, 2014

Graetz: The Tax Reform Road Not Taken -- Yet

Michael Graetz has been working away at convincing Americans to accept a national level consumption tax, and he has another go at it with The Tax Reform Road Not Taken -- Yet. Here is the abstract:

The United States has traveled a unique tax policy path, avoiding value added taxes (VATs), which have now been adopted by every OECD country and 160 countries worldwide. Moreover, many U.S. consumption tax advocates have insisted on direct personalized taxes that are unlike taxes used anywhere in the world. This article details a tax reform plan that uses revenues from a VAT to substantially reduce and reform our nation’s tax system. The plan would (1) enact a destination-based VAT; (2) use the revenue produced by this VAT to finance an income tax exemption of $100,000 of family income and to lower income tax rates on income above that amount; (3) lower the corporate income tax rate to 15 percent; and (4) protect low and-moderate-income workers from a tax increase through payroll tax credits and expanded refundable child tax credits. This revenue and distributionally neutral plan would stimulate economic growth, free more than 150 million Americans from having to file income tax returns, solve the difficult problems of international income taxation, and remove the temptation for Congress to use tax benefits as if they are solutions to the nation’s pressing social and economic problems.

Prof Graetz has been working on this idea for quite some time and he's likely right that a national consumption tax would solve some major problems for the US income tax system. It would reverse the "income" tax from a mass tax to a class tax again, refocusing the income tax regime on its most productive base, namely, the upper-middle class. It would go a long way (but not by any means all the way) in resolving some of the worst aspects of citizenship taxation. It is just a fact that including non-residents as if they were resident throws people right into the deep end of US tax law even if they are regular working class households, because everything they do is "foreign" and therefore subject to the world's most complicated anti-avoidance regime. Eliminating income taxation for a large majority of those people would go some steps toward a remedy without actually fixing the fundamental problem.

But Prof Graetz's has been an uphill battle. I can think of at least two main reasons for this: first, introducing any new tax is political suicide in the US and second, it would be little more than a double tax (for those that would remain in the income tax system) because the US income tax is in large part already a consumption tax in that it exempts so much in the way of savings. As we know from Haig-Simons, income equals consumption plus delta savings over the period. When savings are exempt, income taxation is equivalent to consumption taxation. So introducing VAT in the US means imposing a new consumption tax on the very same base as something we currently call an "income" tax.

For those that would be exempt from the income tax, the VAT would simply step in and claim roughly the same amount of tax, and therefore presumably the picture wouldn't change much in terms of revenue raised, but would change quite a lot in terms of form filling and paper filing, which means less administration for the same tax. That would be great for the ever-starving IRS. (A cynic might observe that it could mean less from penalties from those who fail to file things properly, which is set to become a most fruitful source of extra revenue in just a couple of weeks.)

Moreover, the switch from an income tax system that ultimately acts like a consumption tax to a straightforward an easier-to-administer consumption tax might solve the revenue problem, but it would still need cash transfers to solve the progressivity problem and therefore can only be solved with another form of political suicide, namely, increasing welfare payments to the poor (that's the "refundable credits" part of the plan).

Still, worth reading and watching as Prof Graetz continues to wage what often seems like a one-man battle to change attitudes toward a national VAT in the United States. It is striking how difficult it is to convince Americans to embrace a tax that would do almost exactly what the current income tax system does, but at a fraction of the cost. On principle people really still like the income tax and they really hate the idea of a national consumption tax. Cognitive dissonance? Or a naïve hope that the income tax can be restored to its former glory if we can only figure out a way to tax savings again?

1 comment:

While I am a big fan of bringing a GST/VAT to the US their some unique political challenges. One is in most other countries I have looked at with VAT's it was introduced as a COMPLETE replacement for some older type of consumption tax(often with an early 20th century wartime origin) imposed at the manufacturer or wholesale level and often completely hidden to the consumer. The Canadian Manufacturer's Sales Tax in place from 1920 to 1991 was a typical example.

In the US there has never been a wholesale or manufacturers sales tax so a GST/VAT would literally be a completely a NEW tax. The closest parallel to the US situation has been some Canadian provinces like Ontario and Quebec "harmonizing" their retail sales taxes(akin to most US state retail sales tax) to the Canadian Federal GST. Could an individual US State impose a VAT without a Federal Tax to base off of like QC and ON. Perhaps no state though has tried yet even though Quebec's first efforts at VATizing its retail sales tax(TVQ) go back to the start of the Canadian GST in 1991 now almost 24 years ago.

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